Is the credit-deposit ratio of banks still worth tracking?

The credit-deposit ratio of banks in India is around 80% today. Should this be a concern? If the investment–deposit ratio is also considered, which is about 29%, the two together mean that for every ₹100 raised as deposits, almost ₹109 is being deployed as credit and investment. And there is a statutory liquidity ratio (SLR) requirement of 18%, which is counted as part of the 29% invested, and a cash reserve ratio requirement of another 4%. How do these numbers add up?

From the time India went for reforms in 1991-92 to around 2003-04, the average credit-deposit ratio was around 55% and the investment-deposit ratio 33%. This came to less than 90% together, even as SLR mandates were higher. Subsequently, the average credit-deposit ratio rose to 75%, with the investment-deposit ratio remaining at around 30%. This added up to 105%.

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The picture is not really odd, as this is how mature systems behave. To begin with, deposits are not the only source of funding for banks. If the overall balance sheet of the system is looked at for 2023-24, around 77% of total liabilities are in the form of deposits and this has been the average over the years.

However, there are two other components that serve as sources of funding for credit and investment. The first are reserves and surplus, which grow with the profits that are deployed after paying dividends. This is around 8.5% of total liabilities, and growing, depending on how banks perform. As banks earn higher profits, this component goes into the capital structure of banks.

Borrowings are the other component. These can be either Tier 2 bonds raised to support capital or specific bonds like those meant for infrastructure. The share of this component is around 9%. When infrastructure bonds are issued, the funds are on-lent for that purpose alone (i.e., infra development), with banks able to match the time-spans of their assets (or loans) with the length of their liabilities. So, while deposits are the most important source of funding for banks, they are not the only one.

There is a debate over banks using their own capital base to extend credit. The conservative view is that this is meant for a rainy day and should ideally not be used. But then, holding these resources idle imposes an opportunity cost. 

So the alternative view is that using these funds makes sense because safety is already covered by the regulatory concept of a bank’s capital adequacy ratio. So long as a bank has a sufficient capital cushion in relation to its risk-weighted assets, it need not worry about an over-stretch. This school of thought concludes that the credit-deposit ratio is passé as a measure and one must broaden a bank’s sources of funds.

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Let us look at how these ratios are placed in other countries. Banks remain the main source of finance in most economies. While bond markets have evolved to varying degrees across geographies, the credit-deposit ratio varies depending on a market’s level of sophistication.

The US debt market bustles with corporate bonds and IMF data shows that for 2023, its banks’ credit-deposit ratio was 69%. Japan, being strong in bonds, had a lower ratio of 66%. Germany was another market with a ratio of 69%. In these countries, banks subscribe to corporate bonds. Hence, while their direct credit numbers may look low, they make high investments in these debt instruments. In other markets, the picture changes dramatically. 

Banks in Australia had a credit-deposit ratio of 146% in 2023, followed by 114% in South Africa. France’s ratio was 98%, Italy’s was 94% and the UK’s 88%. Among large emerging markets, China’s was 78%, Malaysia’s 109%, Korea’s 111%, Brazil’s 106% and Indonesia’s 82%.

Putting all these pieces together, the following can be surmised. The credit-deposit ratio depends to a large extent on how the debt market is placed. Markets are a cheap source of funding for companies as they do away with intermediation costs. This works well in countries where more symmetric information is available and there are efficient systems in place for addressing defaults. 

Most countries, however, still rely on banks to fund commercial activity and hence their ratio tends to be high, even though they would also be tapping avenues other than deposits.

Is there an ideal credit-deposit ratio? The answer is that a specific level is hard to target, especially in an economy that’s heavily dependent on banks for investments. At the turn of the century, 36% of total credit was in the form of term loans. In 2023-24, this ratio had increased to nearly 64%, implying that there is substantial heavy lifting being done by banks in the arena of investment.

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From a regulatory perspective, what may matter more is that prudential norms on asset quality and capital adequacy are strictly met. These are important to preserve the integrity of the banking system. In fact, it can be argued that a bank’s investment-deposit ratio should ideally be lowered, as it may be masking lazy banking, where banks park more funds in safe government securities than the rules require. However, higher investment in government paper has been a result of India’s prospective liquidity cover ratio regulation. 

Hence, while it is necessary to monitor credit growth to ensure that there is no over-lending, targeting any credit-deposit ratio would be difficult. A broader measure of long-term funding, though, could be used as the denominator that goes beyond deposits and captures changes brought by financial sophistication.

These are the authors’ personal views.

The author is chief economist, Bank of Baroda, and author of ‘Corporate Quirks: The darker side of the sun’